First published at China Law & Practice | May/June 2016

Cross-border technology transfers can entail serious regulatoryand commercial risks involving approvals, due diligence, customs and disputes. Chinese importers and foreign exporters can apply these seven solutions.

China has seen a substantial increase in technology import businesses and has rolled out a series of incentives over the past several years to further encourage the transfer of key know-how into its domestic market. In fact, Liu He, former vice-chairman of the Development Research Center of the State Council, wrote in 2013 that China’ s strategic opportunities to acquire cutting-edge technology and invest in infrastructure truly manifested after the 2008 global financial crisis, when the country exerted a great influence on the world’ s economic recovery.

But acquisitions, transfers and import of such crucial and competitive technology are not without challenges. Improper navigation and handling of regulatory and commercial risks can not only break a deal, but can also result in heavy costs for both the importer and exporter for years to come.

“Technology acquisition” refers to the import of technology by China from developed countries. And, more specifically, according to the PRC Regulations for the Administration of Technology Import-Export, “technology import” means the act of transferring technology into the country from abroad by way of trade, investment ortechnical and economic cooperation. Such acts include the transfer of patents,patent application rights and licenses, know-how, technical services and other manners of technology transfer.

Some argue that the term “技术秘密”, which literally means technical secret, can be roughly translated as “know-how” under UK and U.S. law. It encompasses any method, expertise, technology or other information in fields such as industry, commerce and management that is kept confidential, can resolve a specific issue once exploited and has relatively great economic value. Generally speaking, a rights holder will make public and file a patent application for a new technology that can be cracked through reverse engineering, where as a technology that cannot becracked will be preserved as know-how.

It is by no means easy to fully investigate and evaluate the extent of know-how, and so transactions involving such secrets pose a greater risk than other technology deals.

Regulatory issues in technology import

Issues under PRC law will inevitably be encountered when importing technology from across the Chinese border. The transaction and its parties will be subject to regulatory controls, such as those for trade, foreign exchange and tax.

Foreigntrade controls

The Ministry of Commerce (MOFCOM) and its local bureaus are the authorities incharge of technology import. Prohibited technologies may not be imported under PRC law. Restricted technologies require MOFCOM approval and a technology importpermit. Technologies that can be freely imported and exported are subject to online registration. Once the procedure has been completed, the importer is issued a technology import-export contract registration certificate. Exchange control, bank, tax, customs and other procedures are then carried out on the strength ofthe permit or certificate.

“Transactions involving such secrets pose a greater risk than other technology deals.”

The MOFCOM approval process

Under Article 8 of the Measures for the Administration of Technology Import-Export Contracts, contracts for technologies that can be freely imported and exportedmust be registered online.

To do so, a business operator importing or exporting permitted technology must:

Log onto the Technology Import andExport Contract Information Management System on the MOFCOM website (jsjckqy.fwmys.mofcom.gov.cn)

Complete the registration process byproviding:

An application to register thetechnology import/ export contract

A copy of the technology import/export contract (including a Chinese translation)

The documents evidencing the legalstatus of the parties to the contract.

MOFCOM may issue the operator a technology import or export contract registration certificate within three working days from the date of receipt of these documents.

FX controls

An importer will usually encounter exchange control issues when executing the contract. As the renminbi has yet to be fully internationalized, an overseas technology exporter will usually requirethe importer to pay in foreign currency, which involves working with a bank on three steps: opening a foreign exchange account, selling foreign exchange and making the actual payment. Opening an account and paying foreign exchange will usually be problem-free, but, at the foreign exchange sale stage, the bank will require the importer to provide the approval document issued by the exchange control bureau or other supporting materials.

These usually include the technology import contract, payment notice, technology importpermit, technology import contract registration certificate, technology importcontract data form and tax certificate for a payment to a foreign party. For a non-tax-resident,proof of legal status and the tax payer identification number are also required.

Taxes

A recipient—in this case, the importer—is legally required to withhold relevant taxes when paying income sourced in China to a foreign non-tax-resident enterprise or individual. As the importer must provide a “tax certificate for payment toa foreign party” when purchasing foreign exchange, itmust complete its tax withholding obligation or the relevant tax record-filing work before purchasing the foreign exchange and making the payment.

The main challenge the importer may face is that the withholding income tax rate of a foreign non-tax-resident is usually 10% of the transaction price. However, paying customs duties is not required when exporting technology to the PRC, and technology import transactions are exempt from consumption tax, value-added taxand business tax as well, meaning the parties are also free from paying both the urban maintenance and construction tax and education surcharge.

“The withholding income tax rate of a foreign non-tax-residentis usually 10% of the transaction price.”

The key risks to a transaction

The foreign jurisdiction’s export controls

Administrative approval requirements are not only imposed on the importers. Most exporters of know-how are usually from Western developed countries, which, in an effort tomaintain their competitive advantage, often restrict the export of certain technologies through their own regulatory gatekeepers. Take the U.S. as an example: the export control responsibility mainly lies with Department of State and the Departmentof Commerce. If the exporting party to a transaction cannot secure approval from its home jurisdiction, a smooth execution is impossible.

Insufficientdue diligence

As know-how has practical value and must be kept confidential, it is difficult for the importer to conduct full-fledged due diligence prior to the transaction.This includes diligencing the freedom to operate (FTO), which involves investigating whether the application of the technology could infringe another’s patent or violate other laws orstatutes. The inability to access this data means certain risks cannot be accounted for.

The exporter’s delivery

As the know-how being bought or sold mainly comprises intangible knowledge and services, the method of delivery can easily give rise to disputes. When delivering aphysical medium that carries data, such as by storing information on an optical disk or portable disk drive, once the intangible assets are combined with the hardware, legal issues related to customs declaration and supervision mayarise.

Governing law and dispute resolution

Countries have different ways of distinguishing know-how with respect to intellectual property(IP), as well as varying levels of protection. When selecting a disputeresolution institution, parties will consider factors including the legal background, language, culture and costs. As there is often a lack of trust between the importer and exporter at the outset of a transaction, the governing law anddispute resolution mechanism often become the areas where the differences of opinion are the greatest.

“The foreign party can first register or purchase in the PRC a patent, trademark or copyright related to the know-how.”

The seven solutions

In order to reduce the legal risks associated with technology import-exporttransactions, parties can consider the following key features while adhering tothe realities of both the commercial and PRC regulatory climates:

1.  Simultaneous transfer with IP registered in the PRC.

The foreign party can first register or purchase in the PRC a patent, trademark orcopyright related to the know-how. After securing the “dominant” right, it can bundle and transfer it with the “recessive” know-how. This allows the flaws of the“recessive” subject matter to be made up by the “dominant” one.

2.  Payment of the consideration for the know-howin stages: initial fee plus royalty.

As itis challenging for the importer to conduct full due diligence before the transaction, the consideration cannot be fully paid in one lump sum. The parties can opt for a method where the importer first pays a small “initial fee”, and the exporter delivers the technology and provides auxiliary services after the execution of the contract, followed by a pro rata “royalty” charge upon output from applying the know-how.

3.   Retention by the exporter of the right toaudit.

If the initial fee plus royalty payment method is opted for, the right to audit should be retained by the exporter. The exporter has the right to audit, at its own expense, the output value of the imported technology, on which basis the specific royalty fee is then calculated.

4.  The exporter is responsible for delivery to the PRC and providing technical support.

As the exporter best understands the technology that it is transferring, it is better suited to control the risks associated with the delivery of the subject matterand any possible leakage. Accordingly, it is more reasonable for the exporter tobear these obligations.

5.  Each party handles the technology import-export control approval procedures of its own jurisdiction.

The exporter takes responsibility for obtaining approval from the export countryand the importer does the same from the import country. If an approval cannot be secured due to the technology control measures of either jurisdiction, each party bears its respective legal liability.

6.  The importer takes responsibility for with holding the various taxes (levies).

As PRC law provides that the payee, or importer, withhold the domestic income tax of aforeign non-tax-resident and the relevant taxes arising from the transaction,the importer should specify in the technology import-export contract that it will withhold such taxes. The parties should not only specify the various applicable tax rates in the contract, but also leave some room for flexibility to account for changes in tax laws or policies.

7.  The importer selects the governing law andthe exporter selects the dispute resolution institution.

As the importer needs to bring the know-how into China, pay the consideration from China to overseas, and apply the actual technology in the country, the closest regulatory link to the technology import-export transaction is obviously PRClaw. Meanwhile, once the exporter has delivered the know-how, what is largely left is the right to receive remuneration—the impartiality and efficiency of the dispute resolutioninstitution would be its greatest concern. For these reasons, having the importer choose the PRC as the governing law and the exporter select the disputeresolution institution would be most practical.

When strategizing and executing a technology import-export contract, of which the core of the deal is the key know-how, implementing these solutions will go along way in reducing transaction risks and markedly brightening the outlook of success.

Degang Ma, Partner

Jingtian & Gongcheng

34/F,Tower 3, China Central Place

No.77Jianguo Road

Beijing,100025

China

(86 10)5809 1011

(86 10)5809 1100

ma.degang@jingtian.com

Mr. Ma was admitted to PRC bar and New York State bar. Mr. Ma specializes in the area of IP. Mr. Ma is a member of Patent Section of Beijing Lawyers Association.

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